Should I Overpay on My Mortgage?

by , Last Updated: 15 April 2014

We look at whether making overpayments on your mortgage could be a good idea for you.

Pile Of Pound Coins

If you have extra money to spare, you may be considering making overpayments on your mortgage.

This will not only help to reduce the amount you have outstanding but can also help to shorten your mortgage term and, more importantly, the overall amount you end up paying for your home.

However, while this sounds like a fail-safe plan, there are some common pitfalls to watch out for. We show you how to decide if making overpayments will be beneficial to your current circumstances, and explain how to maximise the impact of any overpayments you make.

Why overpay?

In many cases overpaying on your mortgage will save you money in the long-run, by reducing the size of your mortgage and as a result the amount of interest you'll pay overall.

In the current economic climate the best deals tend to be available to those with more equity in their property. So using overpayments to build more equity in your home can put you in a more favourable position when the time comes to look for another deal.

For example you may have a 150,000 mortgage with a term of 20 years, at an interest rate of 5%. 

This would cost you 237,584 in total when paying the standard repayment each month.

However, add a monthly overpayment of 100, and you could cut the cost of your mortgage to 223,327.

This would save you around 14,300, cutting nearly 3 years off the length of your mortgage.

It is generally more tax-efficient to put any spare cash you have available into paying off your mortgage rather than into a savings account, because the interest earned on your savings is taxable (unless you invest in a cash ISA). Therefore, in theory, you should be able to save more money in the long-run by putting your money towards mortgage overpayments rather than stashing it in a low-interest savings account.

The exception to this rule is if the interest on your savings (after tax) is higher than your mortgage rate.

However as this is unlikely to be the case, particularly in the current climate, it  can make more sense to put your spare cash towards chipping away at your mortgage balance - providing you have a nest egg set aside.

What are the drawbacks of overpaying?

While making overpayments can seem like a good idea, there are some points you need to check out first.

  • Does your mortgage lender allow it?

Some mortgage lenders invoke specific clauses that will result in a penalty if you begin paying more than your usual monthly repayment. Therefore it's crucial to check with your lender before you start making over-payments.

If the penalties or additional costs involved in overpaying on your mortgage outweigh what you will save, it will be more cost-effective to put your extra cash into a savings account instead.

If you choose you could leave your money here for the time being until such time as your current deal comes to an end, and you're able to make a penalty-free lump sum repayment. 

  • Are other debts costing you more?

It's worth bearing in mind that if you are planning on overpaying on your mortgage, it will only be wise to do so if you don't have other more expensive debts to pay off. If your other debts are costing you more than your mortgage, it would be a good idea to pay these off first before considering making overpayments on your mortgage.

  • Where the money goes

If you have a repayment mortgage, remember to make sure your overpayments are going towards paying off your overall balance, not just the interest. If you overpay on the interest, this will have no effect on reducing your mortgage cost or term.

On the other hand if you have an interest-only mortgage all your payments will only be going on your mortgage interest. In this case, if you want to make overpayments, you will need to discuss the best course of action with your lender.

  • Don't put all your eggs in one basket

If you use all your available spare money to make overpayments on your mortgage, rather than putting it into a savings account for example, you won't generally be able to get that money back should you need it. So it can be a good idea to keep some back in savings to cover unexpected expenses.

However the one exception to this is if you currently have a flexible mortgage, as these may allow you to make overpayments but borrow the money back if and when you need it.

When is interest calculated?

If you decide to overpay, it's important to time your extra payments according to when your lender calculates interest on your mortgage.

  • Is your mortgage interest calculated daily, monthly, quarterly, or annually? If you aren't sure when yours is calculated, contact your lender or look through your policy documents.

Those whose interest is calculated daily can make overpayments at any time they choose, and the extra amount paid won't be affected by the mortgage interest rate to any significant degree.

However if your interest is calculated monthly, quarterly or annually, it's worth finding out exactly when this is in order to maximise the benefit of overpaying.

As money put towards your mortgage is only counted after interest is calculated, you should try to time it so that your overpayments aren't applied too early.

Try to make your over-payments a day or so before interest is calculated. If you discover that your mortgage interest is not due to be calculated for a few months to a year, it could be cost-effective to put your extra money into a high-interest savings account to ensure it is working as hard as possible, before it is applied to your mortgage.

Should I overpay?

If you are able to overpay on your mortgage penalty-free, doing so can help you save money in the long run while interest rates are so low.

However, you should weigh up your finances thoroughly and decide if you really can afford to overpay. You may decide you can easily afford an extra 100 or so in overpayments in the name of shortening your mortgage term, but it is better to be realistic and consider how this will really affect your finances.

Finally, always check the terms and conditions of your mortgage and speak to your lender before you begin overpayments. If you can afford to make these without incurring costs or putting your finances under too much pressure, it could be a good way to save money in the long-run.

Find our more in our guide: How to compare residential mortgages.

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